Microeconomics: Theory & Applications

Prof. Deep Mukherjee

Department of Economic Sciences
Indian Institute of Technology, Kanpur

Lecture - 01
Introduction

Hello, welcome you all to the exiting world of economics of which microeconomics is a
very important branch.

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Before we start with the lectures let me show you the course text books. First one is by
Pyndyck and Rubinfeld, Indian addition is available. This is an excellent text book you
can definitely read this. There is another one by Hal Varian, and this is one of the leading
text books in microeconomics as well; those who are more mathematically inclined and
wants to learn microeconomics with full regard of mathematics, I would suggest them to
have a look at this great book by Henderson and Quandt. This is also an Indian addition
available.

This course aims you to educate with economic way of thinking, or put in other words
this course would like to teach you with some listning techniques and tools which are
useful to solve some practical economic, financial and managerial problems in the
ordinary business of life. As an academic discipline economics is not really old, but with
passage of time the scope of the subject has grown so wide that it is very difficult to put
forward a simple definition of economics which can be agreed by all.

Let us focus on one definition provided by British economist professor Lionel Robbins
which is considered to be the most acceptable definition of the subject as practiced today.
Let us look at the definition provided by professor Robbins.

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He defined economics as a social science subject. Now note in this definition there are 2
important facts on which we would like to deliver it further.

So now let us look at what do we mean by scarcity and how that is linked with
alternative users which can also be called choices. So, by scarcity we mean that no
human society has all the required resources to produce enough amount of goods and
services to satisfy the materialistic demands of its individuals. And that definition of
scarcity also holds for individual beams.

So, professor Robbins definition actually focuses on this nature of the subject which is
basically can also be called science of economic choice making. So, the society confirms
with the resource scarcity problem. At any point of time with given resources the society
has to produce goods and services so that the societies welfare hits a maximum. That is
basically the problem with which economics the subject deals.
Later professor Paul Samuelson an American economist who is also Nobel laureate tried
to not to put forward a new definition of economics, he tried to explain what economists
do. He said that society at any given point if time confronts 3 basic questions and
economics a subject likes to find the answer for these 3 basic questions. So now, let us
look at what are these 3 basic questions that society faces.

So now, we are going to look at professor Samuelson’s work his 3 questions. And note
that these questions immerge because there is scarcity of resources in the society. What
commodities this could be goods and services shall be produced and in what quantities?
Then the 2nd question is; how shall this goods and services be produced given
technological knowhow?

The 3rd question is how is societies total output of goods and services be divided, is
divided? The third question is how is societies total output divided among its members?
Putting other words, for whom the goods and services to be produced?

Later professor Lipsey has added a 4th question to this list. So now, we are moving to
professor Richard Lipsey’s contribution. The 4th question is how efficient is the societies
production and distribution. Now note that here in this definitions we are talking about
society which is basically collection of individuals. Now economics has 2 major
branches, microeconomics and macroeconomics, the branch microeconomics talks about
the individual’s problem.

So, here in the course we are not going to look at society as a whole how it is facing
different economic problems and how it is trying to solve different problems, rather we
would like to see how a particular consumer, how a particular firm is facing economic
problem and trying to optimize their decisions, their welfare given the recess constant it
faces.

Now we are going to study themes of microeconomics.

(Refer Slide Time: 10:26)

First we are going to talk about tradeoffs then we are going to talk about opportunity
cost. The 3rd item is marginal analysis. 4th item is price and market mechanism. The 5th
item is equilibrium. The next item would be theory and models and the last item in the
list would be positive and normative analysis.

Let us now start with the problem of tradeoffs. We have already noted that beat a society
or an individual the economic agents face with the problem of resource constant. Take
the case of a household. The household has a given income so, with this given set of
money they cannot buy everything that they want. The persons you know in a household
may wish to have a luxurious car, but the income or the wealth that they have that may
not be good enough to buy them a car. So, when a individual or a household makes small
choices in ordinary business of lifes. Suppose you know a household or a person is
choosing to purchase a (Refer Time: 12:57) then that is also because of the state of the
same problem is faced by farms also.

Suppose we take the case of a multi-product farm, a farm which produces a more than
one goods and services. Now a farm also starts with given resource constant, and the
farm has to decide how many units of good x to be produced and how many goods of
how many units of good y to be produced the firm cannot make as many as number of
goods x and y as it wishes it is constant by the resources. What are these resources?
These resources are like work force, natural capital or natural resources like raw
materials and physical stock of capital.

Now let us move on to the concept of opportunity cost. Once another Nobel laureate
professor Milton Friedman opined that, there is no such thing as free lunch. Now what is
the reason behind this popular phrase? Note that even in this case when you are not
paying for the lunch box, there is still some trade off and because of this trade off
opportunity cost is arising. Suppose the society decides not to produce the lunch box for
you. So, the labor, capital, land etcetera which had been employed to produce food and
the lunch box for you, it could have been employed elsewhere to produce some other
good.

So, the society sacrificing some other good or services to produce one unit of lunch box
for you. It is free for you, but it is not free for society. Your lunch box comes at a cost for
the society. Think about the friend who has offered you that free lunch box. Of course,
that person has paid some money, now if he or she had decided not to buy that free lunch
for you he or she could have used that money to buy some other good and services for
him or her. So, of course, that person also sacrificed to provide you a free lunch.

Now, let us define opportunity cost because it is a very important concept in economics.
Stated otherwise, it is the cost of not choosing the next based alternative. So, the point is
that as society or any individual economic agent is always confronted with the problem
of making choices. And each final choice has opportunity cost in terms of an alternative
not chosen.

Now let us consider the 3rd in the theme list which is called marginal analysis. Towards
late 19th century, there is some of search of research in microeconomics and economics,
and it is known as marginalist revolution. So, what is marginalism? It is a new term
marginalism became very popular with this book published by professor Alfred Marshall
a British economist, and the name of the book is Principles of Economics which got
published in the year of 1890.

This concept of marginalism is now an integral part of economic analysis, it is very

important. So now, let us look at what do we mean by marginalism. So, we will first
define it and then we will discuss. So, marginal analysis investigates the effects of
infinitesimal which means very small change and this change could be addition or
subtraction from a current situation.

So, as per the marginal analysis a national economic agent considers taking a move or
taking an action by comparing the additional benefits of an activity to the additional cost
of that activity if taken. And if he or she finds that the additional benefit from this
marginal change is higher than that additional cost of this particular action taken, then he
or she will take it otherwise not. Now having studied marginalism, trade off and
opportunity cost, we should also comment that this 3 items or themes are linked with
each other. Because there is resource scarcity the individual economic agent or society
faces the choice problem. And as the person faces choice problems or society faces a
choice problem there is opportunity cost.

Now, before we move on to the other items in the themes list, let us study a concept
which is linked with these 3 themes. And the concept is known as a production
possibility curve or production possibility frontier.

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First we are going to define the concept and then we are going to provide a graphical
illustration of the concept. PPF or PPC shows the maximum contribution, combinations
of 2 goods that can produced with full employment of given resources and given
knowledge of technology. Two things are very important to note down, that we are
talking about full employment of given resources, and we are also talking about a given
state of technology.

In the next lecture, we are going to study this concept of production possibility frontier in
greater details.